as 18 related party
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Amit Majmudar April , 2009
Accounting Standard 18 Related
Party Disclosures
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AS - 18 - Contents
Scope
Specified Related Party Transactions
Parties not to be treated as Related Parties
Definition of control, significant influence and Key managementpersonnel
Examples of Related Parties
Disclosure requirements
Provisions of Clause 49 Corporate Governance
Key Issues
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AS 18Scope:
- should be applied in reporting related party relationshipsand transactions between a reporting enterprise and itsrelated parties
- the requirements of this Statement apply to the financialstatements of each reporting enterprise as also toconsolidated financial statements presented by a holding
company
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AS 18 The statement deals only with specific related
party transactions as specified below:(a) enterprises that directly, or indirectly through one or moreintermediaries, control, or are controlled by, or are under commoncontrol with, the reporting enterprise (this includes holding companies,subsidiaries and fellow subsidiaries).
(b) associates and joint ventures of the reporting enterprise and theinvesting party or venturer in respect of which the reporting enterpriseis an associate or a joint venture.
(c) individuals owning, directly or indirectly, an interest in the voting
power of the reporting enterprise that gives them control or significantinfluence over the enterprise, and relatives of any such individual.
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AS 18
(d) Key management personnel (KMP) and relatives of such personnel
(e) enterprises over which any person described in (c) or (d) is able toexercise significant influence. This includes enterprises owned by
directors or major shareholders of the reporting enterprise andenterprises that have a member of key management in common withthe reporting enterprise
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AS 18The following are deemed not to be related parties:
- two companies simply because they have a director in common (unless thedirector is able to affect the policies of both companies in their mutual dealings)
- a single customer, supplier, franchiser, distributor, or general agent with whoman enterprise transacts a significant volume of business merely by virtue of theresulting economic dependence
- the parties listed below, in the course of their normal dealings with anenterprise by virtue only of those dealings (although they may circumscribe thefreedom of action of the enterprise or participate in its decision-makingprocess):
Providers of finance
Trade unions
Public utilities
Government departments and government agencies including governmentsponsored bodies
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AS 18
Control
Own more than voting power Control over composition of board
Substantial interest in voting power and power to direct financialand/or operating policies
Significant Influence (participation in the financial and/oroperating policy decisions of an enterprise, but not controlof those policies)
Representation on board
Participation in policy making
Material inter-company transactions
Sharing of managerial personnel
Dependence on technical information
Ownership of 20% or more
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AS 18
Key management personnel
Those persons who have the authority and responsibility for planning,
directing and controlling the activities of the reporting enterprise.
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Enterprises that directly, or indirectly through one or more
intermediaries, control, or are controlled by, or are under
common control with, the reporting enterprise (includes
holding companies, subsidiaries and fellow subsidiaries);
A Ltd60%
Reporting
Enterprise
40%
B Ltd 15%
A Ltd60%
Related Party
Reporting
Enterprise
40%
B Ltd 15%
AS 18
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AS 18
Related parties include associates and joint ventures
Reporting
Enterprise
Company S
Company H
Company F
60% 55%
Company SI
21%
Reporting
Enterprise
Company S
Company H
Company F
Related Party
Company SI
50%
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Associate joint ventures of the enterprise and investingparty or venturer in respect of whom the reporting entity
is an associate or joint venture
Company I
Reporting
enterprise
Company JVCompany A
Company CV
Company I 2
40%60%
60%40%
5% with an agreement
for management
JV
JV Associate
Company I
Reporting
enterprise
Company JVCompany A
Company CV
Company I 2
40%60%
60%40%
5% with an agreement
for management
Related Party
JV
JV Associate
AS 18
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Enterprises over which controlling individuals/relatives or
KMPs/relatives are able to exercise significant influence. Thisincludes enterprises owned by directors or major shareholders of
the reporting enterprise and enterprises that have a member of
key management in common with the reporting enterprise
Individual
Reporting
enterprise
25%
Partnership
firm
1:1 PSR
and capital
MD of Reporting
Enterprise
Company S
Company D
MD of Company D
80%
Example 1 Example 2
Individual
Reporting
enterprise
25%
Partnership
firm
1:1 PSR
and capital
MD of Reporting
Enterprise
Company S
Company D
MD of Company D
80%
Related Party
AS 18
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AS 18
Disclosure requirements:
Where control exist: Name of the related party and nature of the related
party relationship should be disclosed irrespective of whether or not there
have been transactions between the related parties.
If there have been transactions between related parties, during the
existence of a related party relationship, the reporting enterprise should
disclose the following:
Name of transacting related party
Description of relationship
Nature of transaction
Volume of transactions
Other key elements
Outstanding balances & provision for doubtful debts
Amounts written off or written back
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AS 18 Para 26 of AS 18:
Items of a similar nature may be disclosed in aggregate bytype of related party except when separate disclosure isnecessary for an understanding of the effects of relatedparty transactions on the financial statements of the
reporting enterprise.
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AS 18Provisions relating to Related Party Transactions in
Clause 49 of the listing agreement
CorporateGovernance
A statement in summary form of transactions with related parties in theordinary course of business shall be placed periodically before the auditcommittee.
Details of material individual transactions with related parties, which arenot in the normal course of business, shall be placed before the auditcommittee.
Details of material individual transactions with related parties or others,which are not on an arms length basis should be placed before the audit
committee, together with Managements justification for the same.
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AS 18 Key issuesASI 13
Paragraph 26 and 27 of AS 18 provides for disclosure of items of similar naturein aggregate by type of related party except when the separate disclosure isrequired for understanding the effects of the transaction.
However, this is not done in such a way as to obscure the importance ofsignificant transactions. Nor a material related party transaction with anindividual party is clubbed in an aggregated disclosure.
Issue: How the test of materiality should be applied.
Depending on the circumstances, either the nature or the size of the item
could be the determining factor. As regards size, ordinarily a related partytransaction, the amount of which is in excess of 10% of the total related partytransactions of the same type (such as purchase of goods), is consideredmaterial.
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AS 18 Key issuesASI 19 Interpretation of the term
intermediaries
The term intermediaries should be confined to mean
enterprises which are subsidiaries as defined in AS 21,Consolidated Financial Statements.
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AS 18 Key issuesASI 21 Non executive directors on the board
whether related parties
A non executive director should not be considered as keymanagement person unless he has a authority andresponsibility for planning, directing and controlling the
activities of the enterprise.
The requirements of AS 18 should not be applied in respectof non executive director even if he participates in the
financial and / or operating policy decisions unless he falls inany categories in para 3 of AS 18 (the specified relatedparty transactions).
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AS 18 key issuesIssue:
What are the connotations to "planning, directing and controlling the activities of
the reporting enterprise"? Whether it is at strategic, functional or micro level?
Resolution:
Since key management personnel needs to have all the three authorities andresponsibilities of planning, directing and controlling the activities, such personwill be at strategic levels (with functional responsibility) for the reason thatemployee at functional level will have the authority (& also responsibility) only to
execute, direct and control the activities as already decided at strategic level.
He will not be involved in planning stage per se. The planning of activities whichhe does is not planning as such but a functional plan to execute a broaderstrategic plan.
Further the directing and controlling of activities will be at much lower levels(micro or functional) and therefore such persons should not be deemed as keypersonnel for AS 18 purposes.
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AS -18 Key issuesFurther, AS 18 examples also talk about Managing Director, Whole TimeDirector, manager or any person according to whose instructions Board of
Directors is accustomed to act.
The employee at functional level will not have any powers per se to influence theBoard of Directors or their activities ( but may in a limited way influence themfrom time to time by presenting a proper case or path).
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AS 18 Key issuesIssue:
In case of Joint Ventures entered into by the Company with other parties, there iscontrolling interest of more than 20% (in most of the cases the interest is 50%).There is joint management in all such joint ventures. Under the definition ofControl, para (c) states a substantial interest in voting power and the power todirect, by statute or agreement, the financial and/or operating policies of theenterprise.
Whether as per this definition, the reporting enterprise will also be deemed toexercise control over the joint venture within the meaning of para 3 (a) of the AS,irrespective of the fact that it will still be a related party within the meaning of para3 (b) of the AS. In case it is deemed to exercise control, then as per para 21 ofthe AS, names of the related parties are to be given irrespective of whether ornot there are any transactions.
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AS 18 Key issuesResolution:
For purposes of consolidation, AS 21 defines control as:
(a) own more than 1/2 of voting power
(b) controls the composition of the board
For purposes of AS 18, related party transactions, control includes the above two
factors plus 'a substantial interest in voting power and the power to direct, bystatute or agreement, the financial and/or operating policies of the enterprise'.Therefore a related party may exercise control over another enterprise, which isnot subject to consolidation.
The relationship with the joint venture will fall under the definition of 'control',names of such related parties should be given irrespective of whether there isany transaction or not.
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AS 18 Key issuesIssue: The Company is a joint venture of X and Y (50:50). Z is the 100% holding company
of X. Are the following transactions required to be disclosed as related partytransactions?
(a) The Company pays 8% sales commission to Z for the sales promoted by them oncompany's behalf.
(b) The Company is required as per the agreement to pay license fee and salescommission to X which is not paid and a certificate of waiver has been received forthe year.
Resolution:
(a) X is a 50% Venturer and accordingly Z has the joint control over joint venture throughX. Joint control does not give the power to direct financial/operating policies to anyone Venturer as decisions are taken jointly. Therefore paragraph 3(a) of AS 18cannot be said to be applicable.
(b) Waiver of income/expense is a related party transaction. A transaction under AS 18is defined as ' a transfer of resources or obligations between related parties,regardless of whether or not price is charged'. Therefore waiver would be atransaction.
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AS 18 Key issuesIssue:
The Company has transformed the application money paid to Y Ltd (which is a relatedparty) for Deep Discount Bond (DDB) in to security deposits for a property taken on leasefrom Y Ltd. Application money was given in the previous year. In the current year, the DDBallotment is cancelled and the refund money is transformed into security deposit. Whetherthe disclosure should be specifically made stating that amount in the form of application forDDB converted in to Security deposit during the year?
Resolution:
All related party transactions are required to be disclosed. Related party transactions areany transfer of resources or obligations between related parties regardless of whether ornot a price is charged.
AS 18 requires the disclosure for nature of the transaction. Accordingly, the transactionwith Y should be disclosed by way of giving the description. In the given example, thedescription should state that application money for DDB being converted into security
deposit. It will not be correct to show only outstanding amount as security deposit at theyear end, since the transaction of transforming refund money into security deposit hastaken place during the year, which needs to be disclosed.
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AS 18 Key issuesIssue:
The Company has been provided with the technical information and formulationby Z Ltd. Z Ltd is the owner of the product brand which is manufactured andmarketed by the Company. The Company pays royalty to Z Ltd as per the licenseagreement and also the raw materials are imported from Z ltd. Whether thedisclosure of Z Ltd is required in the event they are considered to have asignificant influence?
Resolution:
Paragraph 13 of AS 18 states that significant influence may be exercised inseveral ways. One of the examples given in this paragraph is by way ofdependence on technical information. However, definition of related parties as
per paragraph 3 of AS 18, does not include as related parties the enterpriseswhich have significant influence over the reporting enterprise. It includes onlyindividuals having significant influence over the enterprise. In the present case, ZLtd, not being an individual, will not be covered by the related party definition.
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AS 18 Key issuesIssue:
A listed Company , has made donations to a trust formed for charitable andsocial development purposes. The settler of the trust is the Managing Director ofthe Company. The three trustees are heads of the finance and certain businessdivisions of the Company. MD as the settler of the trust , has only initiated theformation of the trust as an one time action( like initial subscriber to thememorandum in case of companies). He has no role to play in the functioning
and activities of the trust which are driven by the trust deed and monitored by theboard of trustees. The trustees are not key management personnel of thecompany as they are only the business unit heads. Hence the trust does not fallinto the category of the enterprises directly or indirectly controlled by thereporting entity
Whether the donations made need to be disclosed as a related party
transactions?
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As 18 Key issuesResolution:
As per the definition of related party in para 3 (a) of AS 18, which includesindirect control, the enterprise is able to exercise significant influence on thetrust. If it was not the intention of the enterprise to control the trust, why would itnot appoint independent trustees. In many cases of the trusteeship the employeeholds expires with the termination of his employment itself. Even by virtue of thecorpus of the trust being funded by the enterprise, it would have control over thetrust. The trust would also be a related party based on definition in para 3 (e) ofAS 18 if the MD is able to exercise significant influence on the trust. In the
present case, one needs to see the function of the MD in the trust and whatpowers are given to him and whether he can influence the operations of the trust.Given that the divisional heads report to the MD, the MD would be in a position toinfluence the working of the trust though he may have been titled only as asettler.
The fact that the trust is a charitable trust should in no way influence judgementon AS 18. One needs to look at the trust deed and the minutes of the meeting toget more clarity. The bottom line is that if as an enterprise it can exercisesignificant influence or control over another enterprise, then it is a related party.The trust is a related party under AS 18.
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AS 18 Key issuesIssue:
Under para 3(b) of the AS - 18, related party includes associates and jointventures of the reporting enterprise and the investing party or venturer in respectof which the reporting enterprise is an associate or a joint venture. Whether, asper this definition, the other parties in the Joint Ventures of the reportingenterprise will also be construed as related party. For example, reportingenterprise A has formed a joint venture C with another enterprise B. Whetherenterprise B will also be falling within the definition of related party for the
purpose of reporting enterprise A.
Resolution:
A co-venturer is not a related party, though a venturer and the joint venture arerelated parties. Between co-venturers there does not exist any significantinfluence or control. However co-venturers may be otherwise related, forexample if they otherwise exercise significant influence or control over eachother.
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AS 18 Key issuesIssue:
Whether disclosure under AS 18 on Related Party Transactions require auditor'sopinion on the measurement of such transactions?
Resolution:AS 18 does not deal with measurement issues. But that does not exemptauditors from looking at related party pricing. After all auditors give the opinionthat the accounts are true and fair, and it would be difficult for auditors to escapefrom this responsibility should something major go wrong. Auditors also reportspecifically on these issues in the CARO.
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AS 18 Key issuesIssue:
The Company is a subsidiary of ABC International BV, a company incorporatedin the Netherlands, which holds 74 percent of the equity shares. The balance 26percent shares are held by ABC (Mauritius) Limited, a company incorporated inMauritius. All of these companies are part of the ABC Group of France, which isa leading independent Company. The ABC Group is very closely held andprivately owned. The Company is principally engaged in marketing of finished
dosage forms, based on active pharmaceutical ingredients imported from XYZLaboratories ABC (XYZ), France and ABC Egypt Industries (AEI), Egypt; boththese companies are also part of the ABC Group.
During the current year, the companys turnover has exceeded Rs 50 crores, andconsequently certain accounting standards including AS 18 on Related PartyDisclosures have become applicable to the Company.
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AS 18 Key issuesIssue (continued)
Paragraph 21 of AS 18 requires the name of the related party and nature of the relatedparty relationship where control exists to be disclosed irrespective of whether or not therehave been transactions between the related parties.
The Company does not have information about the ownership of its holding company or theownership structure of other entities in the ABC Group. It is also not aware of the nature ofrelationship with other ABC Group entities with whom it enters into transactions.
The Company in its Transfer Pricing Report and Form 3 CEB for the year ended March 31,XXXX, has disclosed that the Ownership pattern of the associated enterprises asdisclosed under Attachment 1 are not available with the assessee.
Considering that the Company is aware of only the identity of its immediate parent, thedisclosures relating to names of parties where control exists may not be complete.Further, considering that the Company is not aware of the exact nature of its relationship
with other group entities, it may not be appropriate to describe these relationships as thatoffellow subsidiaries
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As 18 Key issuesIssue (continued)
In view of the above facts, the following issues need to be resolved:
What disclosures are required to be made in the financial statements relating tothe above?
Would the auditors report require modification to bring out the possibility ofincomplete disclosures, arising from lack of information with the Company?
Resolution:
Any procedures that may have been performed by the company for identificationof related parties and transactions with them would be inadequate and notcomprehensive. To this extent auditors may have to give a limited disclaimer oncompliance with AS 18 as well as on the true and fair view. Such limiteddisclaimer will be based on materiality - but in the absence of any comprehensiveinformation, materiality of the undisclosed information cannot be assessed.
Further, in the absence of information the disclosure requirements as perSchedule VI also can not be met.
The auditor should give limited disclaimer in respect of Schedule VI and AS 18disclosers.
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What should we look for:
Completeness
Manner of disclosure
Shareholding, Investments, 301 Register, TP report,
JV agreements, Prior year work paper
Entitys procedures for identifying Related parties
AAS 23
Management representation
AS 18